Discussion:MFS-50/50 shareholder in s-corp

I have a new client, just contacted me yesterday, about doing his taxes. He and his wife are separated. They have agreed to have the husband deduct 100% of the house and the wife will take 100% of the s-corp losses...even though they are 50/50 shareholders. The husband did not give me a k-1 for 2008, but in his 2007 information there was a K-1...with a significant loss.

I guess my question is this--

Can the husband just not take the loss (given that he has basis to take the loss...which I do not know at this point) and the wife take the entire 100% loss, even though she will receive a K-1 for only half of the loss? Seems like it will cause a flag with the IRS, but I can't find anywhere an example of this happening.

Thanks for any help you can give me!

Do the right thing for your client based on what info he gives you.

For just my own knowledge, is it possible for a MFS 50/50 shareholder that is husband and wife, just one of them deducting 100% of the loss then?

I realize there's a separate issue of how their relationship is now, how he wants to work with her, and whether he would get "credit" by a judge for using my method below if they divorce. I'm going to skip this issue.

But, otherwise, I see a way out of this, keeping the effects of the original agreement intact.

Have whomever prepared the 2008 1120-S redo the K-1's, properly, to both shareholders, and file an amended return. Have each shareholder-spouse do their 1040's. Prepare a separate 1040 (that she never files) for the wife how it would be if she got a K-1 as if she were the only shareholder. Calculate the monetary difference to her based on refund/tax owed of her two returns. Have him write her a check for the difference.

Or, also prepare a 1040 (that he never files) for the husband how it would be without a K-1. Calculate the monetary difference to him based on refund/tax owed of his two returns. Have him write her a check for the difference.

Or, do both, and average the two to determine the amount to write a check for.

Of course, if any of the returns prepared (even the never to be filed ones) have an NOL instead of just a larger refund, some type of agreement would be needed to handle that future value.

As far as her otherwise getting in trouble for deducting the entire business loss, I would guess that she would be unnoticed if the 1120-S improperly listed her as 100% shareholder. Still wouldn't make it right, and if IRS ever found out that was untrue, then I could see her getting in trouble.

Another issue to consider is what's happening with the S Corp going forward? Are they shutting it down? Are they both critical to running the business? Are they going to be able to work together in the future? (I've heard these types of divorces can happen.) Is she effectively taking over the S Corp? If so, he could sell her his shares and under a de minimis rule of stock transfers between spouses or incident to a divorce, she would take over his basis. Perhaps they could backdate a share-sale agreement into 2007. This could be unethical, or illegal, I'll let others chime in on that who have a better understanding of the ethics/legality of backdating such a transaction.

It's possible to put it on a tax return, but it's wrong.

Harry--I knew it was wrong...just wanted reassurance that it was before I did anything more about it.